Financial Review

Wednesday, June 18, 2014 – Forecasts Are Subject to Change

Forecasts Are Subject to Change

by Sinclair Noe

 

DOW + 98 = 16,906
SPX + 14 = 1956
NAS + 25 = 4362
10 YR YLD – .04 = 2.61%
OIL – .15 = 105.72
GOLD + 5.80 = 1278.50
SILV + .14 = 20.00

 

The Federal Reserve FOMC meeting wrapped up today. The Fed issued a statement that was almost a carbon copy of the April statement. The Fed said that growth “has rebounded in recent months” and the labor market indicators “generally showed further improvement.” The central bankers noted that business fixed investment had “resumed its advance” after saying that it “edged down” in April. The only negative comment was that the housing sector “remained slow.”

 

The Fed will hold interest rates steady for now, and probably well into next year; and they will continue to cut back on their large scale asset purchase program by another $10 billion per month. So, starting in July, the Fed will only buy $35 billion in Treasuries and mortgage backed securities.

 

The Fed statement was generally upbeat: “Economic activity will expand at a moderate pace and labor market conditions will continue to improve gradually. Household spending appears to be rising moderately and business fixed investment resumed its advance.”

 

Fed Chairwoman Janet Yellen held a press conference and the topic of inflation was brought up. The feeling is that the Fed wants to see solid signs of recovery, and inflation isn’t a concern; those inflation numbers are just “noise”, according to Yellen. Yellen said: “The data we’re seeing is noisy, inflation is rising in line with expectations.”

 

So, when you pay 7.7% more for hamburger, or 4.2% more for milk, or 5.8% more for airline tickets, or 5% more for car insurance; don’t worry, it’s just noise. You might want to wear ear plugs the next time you fill up at the gas station.

 

Yellen figures the stock market valuations are not out of historical norms, so even though the markets are trading around all-time highs, there are no bubbles forming. And the low volatility is not due to complacency, which is the actual definition of low volatility.

 

The Fed has been forecasting stronger growth right around the corner, and that is still the long range outlook, but the first quarter threw a monkey wrench into the forecast; blame it on the weather, or whatever. They now forecast GDP to rise 2.1% to 2.3%, down from the 2.8% to 3% forecast in March. Once again, strong growth is just over the horizon, like a carrot dangling just in front of a horse.

 

The markets just love an accommodative Fed. The S&P 500 hit a record high close, the Dow rebounded for nearly a hundred point gain, bond prices move higher, even small caps got dragged along for the ride.

 

Recessions are often considered to be over when there have been two quarters in a row of positive growth. The euro zone hit that mark when it squeezed out annualized growth of 0.5% in the third quarter after growth of 1.3% in the second quarter. Not so fast, at least according to economists at the Center for Economic Policy Research; they say the Euro-recession is merely hibernating; growth is still too weak and unemployment too high to declare the recession over.

 

The research group says that economists and policy makers should look more broadly at other indicators, like the sustainability of growth and unemployment. Joblessness in the euro zone is 11.7%, just below a record. The recession that began in mid-2011 is the longest since the group began keeping track in 1970. A committee of the group said in a statement: “Since early 2013 the euro area has witnessed a prolonged episode of extremely weak growth in economic activity. Labor markets have shown little change over that period.”

 

The International Monetary Fund is warning that the legal defeat Argentina suffered Monday in its decade-long fight against holdout bondholders could ricochet around the world’s sovereign debt markets, saying: “We are concerned about possible broader systemic implications.”

 

Last year, the IMF warned that if Argentina lost its case against creditors, the case could set a precedent that gives holdouts outsized power over nations struggling to pay back their debts. That, the IMF warned, could undermine sovereign debt restructurings around the globe. Cutting the amount of debt owed to creditors is a last-chance emergency measure sometimes needed to prevent the collapse of entire economies.

 

The IMF, the Group of Seven leading industrialized economies and others will have to rethink their reliance on sovereign immunity for getting restructurings done and courts around the globe will be forced to resolve conflicts between the Argentina legal case and their own law on sovereign debt. Financial markets are being forced to write new contracts that avoid complicated fights that leave creditors and borrowers in legal limbo for years.

 

For its part, the IMF is  reassessing how it handles the debt of countries in crisis. If a country can’t pay its debts, the IMF has traditionally only considered forcing a debt restructuring as a condition for an emergency fund loan. Now, it is considering offering an alternative: extending bond maturities.

 

In the past the IMF said that while bail-in measures would be voluntary (ranging from rescheduling of loans to bond exchanges that result in long maturities), creditors would understand that the success of such measures would be a condition for continued Fund support for the adjustment measures. Later this week, the IMF plans to post its latest policy musings on the issue.

 

Meanwhile, lawyers for Argentina say they will meet with hedge funds in New York, later this week to negotiate with hedge funds that held out on a partial payment for bonds. Argentine President Cristina Fernandez Kirchner has labeled the holdout investors “vultures” for picking over the carcass of the broken economy in the wake of the 2001-2002 default. In a televised address to the nation yesterday she said Argentina was the victim of “extortion” by the holdouts, but that she was still open to negotiations and insisted she would continue to pay the more than 90 percent of creditors who accepted the restructuring terms in 2005 and 2010.

 

Mary Barra, chief executive of General Motors, came under renewed attack today from lawmakers who were not satisfied with the company’s investigation into its delayed recall of millions of cars and challenged her on whether its most recent recalls should have been made earlier.

 

One congressman produced a string of internal emails from 2005 that showed that one GM employee had experienced a stalling problem in a Chevrolet Impala. The employee said in an email that the Impala she was driving had inexplicably shut off when she hit a bump in the road.

 

“I think this is a serious safety problem, especially if this switch is on multiple programs,” she wrote in an email to another GM employee. “I’m thinking big recall.”

 

As early as December 2000, drivers of the Chevrolet Impala and the other newly recalled cars began lodging complaints about stalling with the National Highway Traffic Safety Administration. That vehicle, however, was not recalled until this week, when the Impala was among 3.36 million cars worldwide recalled for a faulty ignition key. Those vehicles recalled were in addition to the 2.6 million Chevrolet Cobalts, Saturn Ions and other small cars with a defective ignition switch that the automaker has linked to at least 13 deaths and 54 crashes.

 

Barra testified that she did not believe that recalls were routinely avoided in the past. “If there was a serious safety problem, a recall would have been done,” she said.

 

In the end, the panel said it would continue to investigate G.M., including the role of safety regulators, and may hold more hearings on the subject.

 

Send in the drones. Iraq has asked the United States for air support in countering Sunni rebels. General Martin Dempsey, the chairman of the US military’s Joint Chiefs of Staff, gave no direct reply when asked at a Congressional hearing whether Washington would agree to the request. ISIS has essentially taken over a major oil refinery in northern Iraq, but the Maliki government says they have not lost the refinery and government troops are still holding on; but if they are holding on, it’s by a thread. The big oil companies are evacuating some of their employees from refineries in the south. Iraqi troops are holding off Sunni fighters outside Samarra north of Baghdad.

 

The stunning and unexpected victories by the Islamists are very worrisome. In a region that is no stranger to conflict, this one is particularly frightening and has far-reaching consequences, including the threat of spin-off groups similar to ISIS taking root in surrounding nations.

 

A militarily successful Islamist force straddling over parts of Iraq and Syria will pose a real threat to the security and stability of those countries’ immediate neighbors. Even Syria, where government forces are fighting their own civil war, has offered to send troops to Iraq.

 

What appears to be the most likely scenario at this point is that the rapid Sunni militant advance is likely to be stalemated at or north of Baghdad. They will probably continue to make some advances, but it seems unlikely that they will be able to overrun Baghdad and may not even make it to the capital. This scenario appears considerably more likely than the two next most likely alternative scenarios: that the Sunni militants overrun Baghdad and continue their advance south into the Shia heartland of Iraq; or that the Shia coalition is able to counterattack and drive the Sunnis out of most of their recent conquests. That’s what the markets are betting on right now, but forecasts are subject to change.

 

 

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